Pros and cons of corporate bonds.

'Fixed interest of 6.4pc for the next 10 years. What's the catch?'
This week's Diary of a Private Investor looks at the pros and cons of corporate bonds.

By James Bartholomew
Last Updated: 12:17PM GMT 12 Feb 2009

There has been much talk about how savers cannot get a decent rate of interest on money any more. But there is one place where savers can get pretty good rates: corporate bonds. A fixed return of 5pc a year is easily available with little risk. Rates of up to 8pc can be had for those willing to face more danger.

I have bought into corporate bonds for two reasons. One is to get the good yields. The other is because I read recently that a rise in corporate bond prices has preceded all, or at least most, bull markets in shares for many decades. So I hope that the corporate bond market will give me a prompt when it is time to go full-bloodedly back into shares.

What are corporate bonds? They are debt issued by companies in the form of tradable securities. For example, I hold some bonds that were issued by British American Tobacco (or a subsidiary, BAT International Finance, to be precise).

These bonds are due to be repaid in 2019. The "coupon" or rate of interest for a nominal £100 of stock is 6.375pc. But the bonds are quoted at the moment at a fraction below that nominal value, which means the yield is a tiny bit higher. So there it is: fixed interest of about 6.4pc for the next 10 years. What is the catch?

Well, there are a few problems but none that has deterred me. One difficulty is that the market in corporate bonds is a lot less liquid than in shares. It is not always easy to get stock at a price close to the supposed middle price shown by various sources.

The free source I have been using is www.fixedincomeinvestor.co.uk, where you can find a long table of bonds if you go to "bond prices and yields" and then "GBP bonds (Corporate and Non-Gilt)". When I bought the BAT bonds I certainly had to pay 3pc or 4pc above the price quoted. The same happened when I bought some British Telecommunications PLC 8.625pc bonds repayable in March 2020.

But the biggest discrepancy came when I was attracted by the bonds issued by Enterprise Inns with a coupon of 6.5pc but quoted at a mere £40 for £100 nominal of stock. The bond is repayable in full in 2018 so the yield to redemption – which includes the capital gain – looked like a whopping 21.7pc.

But when I got on to my broker to see if I could buy some, I was told the best actual offer was at £66. The price on the screen proved to be pretty theoretical so I held off. Then I read an article that suggested Enterprise Inns might be in danger of breaching the covenants attached to its bonds.

I rang Enterprise Inns hoping that, as an owner of shares in the company, a prospective owner of its bonds and a financial journalist, it might explain more about its covenants. Without going into detail, my attempts to glean information from its investor relations officer (off sick) and its press office proved less than wholly successful.

I was instructed via an outside press relations company to send questions by email. A bad sign. Finally I managed to have a useful conversation with this press company. But the reluctance by Enterprise Inns to communicate left me thinking "why don't they want to talk?"

How safe are corporate bonds? It depends on the company. Safer than Enterprise Inns bonds are those issued by Tesco. They are repayable in 2019 and have a coupon of 5.5pc. They are quoted as I write at 102.4 so the redemption yield is 5.1pc. That is not big enough to tempt me but for those who are desperate for safe income, it is.

Unlike many bonds, this one can also be bought in small amounts – the minimum is apparently £1,000 of nominal stock. Another bond that can be bought on a small scale is issued by Compass Group.

For people who don't want to invest directly, investment management companies can sell you a fund invested in a spread of corporate bonds.

Corporate bonds are a kind of halfway house. They are not as safe as government bonds but they are safer than shares, ranking above them if a company goes bust. The encouraging thing, as far as shares are concerned, is that since November corporate bond prices have been rising.


http://www.telegraph.co.uk/finance/personalfinance/investing/4600899/Fixed-interest-of-6.4pc-for-the-next-10-years.-Whats-the-catch.html